If the government defaults, mortgage rates could surpass 8%

A government debt default could send mortgage rates to highs not seen in over 20 years, a new Zillow analysis suggests.

The unprecedented scenario would send mortgage rates as high as 8.4% in September and the typical cost of a mortgage up 22%, the real estate platform's analysis found. The Treasury Department has suggested the U.S. would fail to meet its debt obligations as soon as June 1, a situation which would significantly disrupt the housing market. 

Mortgage rates could soar past 8% in the unlikely government default scenario, said Melissa Cohn, a regional vice president at William Raveis Mortgage, in an email to National Mortgage News. The rate for average 30-year fixed loans has hovered above 6% in the past six months, after momentarily rising above 7% last fall. The average hasn't surpassed 8% since August 2000, according to data from the Federal Reserve. 

"A government default would depress Treasury bond prices, causing bond yields to rise significantly," she wrote.

The spread of 3-month Treasury yields over 1-month Treasury yields, a barometer of mortgage rates, reached 1.78 percentage points since April 21; the previous high was 0.79 points last October, Zillow said. 

"The gap suggests that investors were requiring much higher interest rates on debt maturing this summer, compared to debt maturing in May, likely due to the risk of delayed or reduced repayment in the event that Treasury hits the X-date without Congressional action on the debt ceiling," wrote Jeff Tucker, Zillow senior economist, in the company's analysis. 

One-month Treasury yields have since climbed to 5.5%, reflecting the looming X-Date, Zillow said. 

If a divided Congress fails to raise the debt ceiling by the "X-Date," or the day when the government runs out of money, home sales would also drop, Zillow said. Existing sales volume, the firm said, would fall 23% to a seasonally adjusted annualized rate of 3.3 million in September from April's 4.3 million rate. 

Specifically, 700,000 fewer homes would be sold between this July and December 2024 in the event of a default, or 12% of the 6 million sales projected in a market without a government default, according to Zillow. Home prices in the scenario meanwhile would remain insulated by low inventory and buyers remaining on the sidelines with elevated rates, dropping by just 1% through next February. 

Zillow puts the average home price at $334,269, a 5% year-over-year gain. Property value growth exploded last summer but has since relaxed, rising at a decade-low pace as of March.

Prices, however, could be dampened by a wave of unemployment, as a federal debt default would put government employees out of work temporarily or permanently. Under the default scenario, Zillow projects unemployment peaking at 8.3% in October. 

A government default would mar the country's credit rating and affect the value of the U.S. dollar, along with disrupting the approximately 9 million Americans who rely on federal wages or funding. The U.S. has never defaulted on its debts.

While the scenario is worrisome, most people don't expect it to happen, Cohn suggested.

"I don't get a sense of great concern from people," she wrote. "Everyone hopes this will not occur as the damage to the economy would be great."